I find it both astonishing and disappointing that so many people either in banking or writing about banking believe the free checking account is the source of today’s bank profitability problems.

I was reminded of this Tuesday after reading Brett King’s article, “Why Durbin will Kill the Branch,” forwarded to me by my blogging partner Joe Swatek. Joe knows that nothing gets me on my soapbox quicker than an article denigrating free checking.

King begins his article mentioning checking account fees. In the second paragraph he quickly establishes free checking as the villain. King writes: “In the US, there are actually people you meet who will tell you that free checking is, or at least should be, a constitutional right. Thus, emotions run high when a bank suggests that you now have to start paying for the right to keep YOUR money with their bank – it’s an outrageous concept to many!”

Paragraph three is spent blaming the banking industry for “training” consumers to demand free checking.

Paragraph four is devoted to explaining why free checking wasn’t really free – at least from the banks’ perspective. While it may not have been free for the bank, it was, and remains, free for consumers. As a long-time free checking customer my only out-of-pocket expenses have been buying checks and paying the infrequent foreign ATM withdrawal fee. Still, as long as I don’t have to keep a minimum balance or pay a monthly fee, it’s FREE checking.

It wasn’t until the fourth paragraph where King finally gets to his point – the Durbin amendment and its negative impact on interchange fee income for the banks. His final three paragraphs get at the heart of the profitability issue – to remain profitable, bankers in the U.S. need to follow the lead of Great Britain and close branches. According to King, since 1990 the number of bank branches in the UK has dropped by half.

At one point King suggests that U.S. bankers are now just waking up to the fact that they need to consider changes to their outmoded business model based on large brick and mortar branch networks.

Having written several blogs about the uncertain future of branch banking, I agree with King’s perspective that it is an outmoded business model.

Where I part company with King is his attempt, like many others, to make free checking the bankers’ whipping boy. It’s a red herring.

Eliminating free checking while introducing new checking account fees and increasing current fees won’t begin to solve consumer banking’s revenue and profitability problems. To invoke one of my favorite analogies – it’s like throwing a deck chair off the Titanic.

It’s a disingenuous argument.

The decision to offer free checking is a classic marketing decision. Many years ago, it was used successfully as a point of differentiation. This was long before high ODP fees and debit card interchange fees.

Consumers loved it as they believed then, and continue to believe today, that they deserve free checking as they are lending their money to the bank interest-free month after month. The fact that things have changed over the years from the banks’ cost and revenue perspective is irrelevant to these consumers. As things have changed, banks have failed miserably in educating their customers about these changes and their impact on account pricing.

Further proof that free checking isn’t the villain it’s portrayed to be is evident in the new “stealth” free checking accounts being offered by the mega-banks and a few followers to replace free checking. For example, the following three mega-banks all offer what I call a “stealth” free checking account which is a checking account that has a monthly service fee which can be easily avoided by simply agreeing to a monthly direct deposit as shown below:

MyAccess Checking from BofA requires a monthly direct deposit of $250 or more.

Chase Total Checking requires a monthly direct deposit of $500 or more.

Agreeing to a monthly direct deposit isn’t generating any additional revenue for these three banks.

In fact, years ago these banks would have been promoting these accounts as Free Checking with Direct Deposit. They had to stop as a result of Regulation DD, Truth in Savings which sets forth strict rules for advertising a checking account as being free.

So the next time you read an article that identifies the ubiquitous free checking account as the root cause of banks’ revenue and profitability problems, you’ll know it’s a classic red herring.

Personally, I think it’s great that the mega-banks and many of the nation’s regional banks have dropped free checking. This enables community banks and credit unions offering free checking to differentiate themselves from the big predatory banks with expensive branches in their market areas.

How Durbin will Speed the Decline in Branch Banking

Brett King, author of Bank 2.0

In the UK and Australia, account keeping fees are nothing new. In the US, however, since the introduction of the Durbin amendment, many US banks have been moving to monthly fees on checking accounts (we call them current accounts generally outside of the US) for the first time. These moves have resulted in often massive backlash from the public, including social media campaigns, “Bank Transfer Day” and further fuel for the Occupy Movement.

In the US, there are actually people you meet who will tell you that free checking is, or at least should be, a constitutional right. Thus, emotion runs high when a bank suggests that you now have to start paying for the right to keep YOUR money with their bank – it’s an outrageous concept to many!

The biggest problem for the US banking industry is that for the longest time it trained customers to believe that this was exactly how they should feel, what they should demand. Advertisers promoted ‘free checking’ for decades as the basic hook for new customers, although it could hardly be called a differentiation. The logic is that there is nothing better than free to attract customers to a new service platform. So how did banks pay for ‘free checking’?

Not really free

Well, it was never actually free. Banks initially made money off deposits (or Assets under Management), but as regulations tightened in the last 2 decades, rates dropped and spreads decreased, margins became razor thin. In th 80s as interest rates climbed, some banks instituted basic fees to combat the cost of savings accounts, but when credit cards became popularized in the 90s, banks now had fallback sources of revenue in credit fees and interchange that could sustain ‘free checking’. A side effect of the Global Financial Crisis is that credit card usage has declined as consumer “saving has become the new spending”, this means that a credit card isn’t working as an offset against basic account costs. With interest rates at historical lows and with no immediate signs of improvement, basic account profitability is at further risk. Then to add to all of this pressure along came the U.S Senator from Illinois, Dick Durbin…

The Durbin amendment to Dodd-Frank, has cut off the lifeblood of interchange fee from larger institutions, many of whom claim it will cost Billions in lost revenue. So while account keeping fees are seen as a mechanism to claw back loses on interchange, I expect it will have a secondary, more subtle consequence on retail banking.

Branch Economics Fail

In the light of revised economics of interchange and debit cards, the first reaction to loss of interchange fee in the US was to try to find new sources of revenue. However, the second reaction inevitably will be a realization that the cost base banks carry to support checking accounts via the branch is no longer viable – network is simply a luxury in a world where consumers just aren’t utilizing physical spaces for their relationship. With the best customers only visiting branches occasionally as they become increasingly digitally enabled, the expense of sustaining a network for a core product or relationship which looks more and more like a cost than a profit, becomes rapidly apparent.

The UK has had more than a decade to deal with this, which is undoubtedly why the UK has halved the number of retail bank branches since 1990. The US, with the false economics of consumer credit and interchange, have paid for their bloated physical infrastructure without the realization of the cost of changing behavior on their distribution model. That realization is now hitting hard as the real costs of an outmoded business model hit home.

Unintended Consequences

The Durbin amendment will give banks the imperative to better manage the economics of their debit card and checking account business. As they are forced to be more disciplined around metrics, two issues will emerge. The first, that while the economics of branch banking are oft justified as supporting high-net worth customer interactions, that increasingly this demographic is moving to digital channels and the branch is no longer the lynchpin in this coveted relationship. How can it be when I use my mobile or internet to talk to the bank 30 times a month, but I visit the branch only twice a year? Secondly, the least profitable customers also are laggards to digital (largely due to adoption cost) and rely more heavily on tree-killing paper statements, ‘free’ checks and over-the-counter interactions.

Once you’re forced to re-examine your cost base in the light of changing distribution, behavior and regulation, the realization emerges that branches are not the profit centre they once were, but are now largely a cost that was hidden by the buffer of high interchange and credit card fees. Couple this with new challenges to the distribution model through Internet direct banks and non-bank FIs who offer better savings rates and lower fees on the basis of better economics, and branch banking will be mercilessly attacked by the big banks looking to retain their earnings-per-share.

The unintended consequences of Durbin may very well be the rapid unwinding of branch banking in the US. It takes a long time to turn the ship, but once that turn starts the momentum of branch closures will speed up rapidly.

First Northern Bank, founded in 1910 in Dixon, California, continues offering Totally Free Checking to its customers in the surrounding counties which includes Sacramento. In addition to Totally Free Checking, the bank also offers 50+ Free Interest Checking (for customers age 50 and older) and Direct Deposit Free Interest Checking. These three checking accounts were originally part of the seven unique checking accounts comprising the “High Performance Checking Account Marketing Program” introduced in 1982 by a direct mail marketing agency in Lincoln, Nebraska. At the time, the direct deposit based account was introduced as VIP Interest Checking. Over the past three decades, most community banks and credit unions participating in the High Performance Checking Account Marketing Program have shortened the Totally Free Checking name to Free Checking. It’s always exciting to encounter a local community bank that continues offering Totally Free Checking, not to mention two additional accounts from the original list of seven. The ad shown below appeared in the April/May 2012 issue of the glossy Sactown magazine.

California’s largest credit union, Golden 1, continues promoting its free checking account. During March, 2012, a simple two-panel marketing flyer or buckslip is being distributed inside the branches in brochure holders located at the teller windows. While this is great news, the words “FREE CHECKING’’ are the smallest words on the front of the flyer as you can see below. And the words “Zero,” “Zip,” and “Zilch,” are not carried forward and explained on the back panel. This particular financial institution has, for years, had its own in-house creative agency which accounts for much of its mediocre creative like the piece shown here. It is very important that banks and credit unions offering free checking continue aggressively marketing the account through multiple marketing channels.

This page-dominant ad for free checking being offered by the Nebraska Bank of Commerce appeared in the January 15, 2012 edition of the Lincoln Journal Star newspaper. The downside to this free checking ad is that it contains what could be mistaken as three competing headlines. The key point to be made with this ad is that “NBC Still Offers Free Checking.” At least this bank, unlike so many today, continues using the name “Free Checking Account” versus less impactful names like Value Checking and Regular Checking. One would hope that more banks and credit unions would spend marketing dollars promoting Free Checking online, in the newspaper, in outdoor, and using radio spots.